China’s COVID bounce takes shape, but…

OMICRON has been imprisoned in Xinjiang:

Mobility is back

Infrastructure is the stimulus tip of the spear:

Energy is back:

Property has rebounded but developer spreads are signalling no end to the trouble:

The PMIs jumped. Pantheon:

China’s June PMIs provided an encouraging sign of a strong recovery from the zero-Covid lockdown.

The surge in the non-manufacturing survey, and the resolution of supply chain problems, are particularly positive surprises, while the continued manufacturing recovery is also welcome. We think much of the strength is driven by China’s reopening, but also see signs that infrastructure stimulus may finally be reaching the data.

China’s official manufacturing PMI rose to 50.2 in June, from 49.6, the first reading above 50 since February. The non-manufacturing PMI, meanwhile, surged to 54.7, from 47.8, thrashing expectations. We had thought the services subcomponent would have a strong month, but expected construction to remain weak, thanks to the pressure on property developers and local governments. We were wrong. Both subindices jumped in June, as shown in our first chart.

Zero-Covid restrictions were eased further in June, most notably with Shanghai finally exiting most controls, leading to a degree of revenge spending.

The jump in the services PMI implies a further recovery of retail sales in June, but year-over-year and quarter over-quarter growth will likely remain negative.

Lockdowns have been in place for sufficiently long that some service sector demand has been permanently lost, so returning to the pre-lockdown norm will take time.

The bounceback in construction, to 56.6 from 52.2, is a good sign for stimulus efforts. But we should note that the index remains below its March level, so expectations of a big FAI print for June should be tempered. We suspect that local governments have finally been able to deploy some of the special bond proceeds now that labour and materials are free to travel once more. But we still think that fiscal tranmission will be muted, given the state of local government balance sheets. Construction also faces a drag from real estate; we think it is unlikely that developers suddenly splurged on investment with revenues still plunging.

Alongside the improving economic outlook, the PMIs also brought good news for global supply chains. In prior Chinese Covid outbreaks, reopening proved a mixed blessing, with port congestion and competition for container shipping adding to snarled supply lines around the world. But delivery times have recovered rapidly following the Omicron outbreak. In manufacturing, supplier delivery times shortened the most since 2016. This should ease any worries about renewed bottlenecks worsening inflation.

Other sources of inflation are also easing.

Manufacturing input and output prices fell in June by over 3 points each, with both now at their lowest since December. Non-manufacturing prices edged slightly higher, but still point to steady services inflation. Our estimate of composite prices fell to six month lows,
as shown in our chart above. Overall, we remain confident that China will be a source of global disinflation this year.

The domestic employment situation improved slightly in June, with both surveys showing an increase in the employment subindex. But the rise was much smaller than the jump in output, and in both cases is still sub-50, implying a continued shedding of staff.

This also chimes with recent comments from PM Li, who spoke on Wednesday of the “arduous” task of stabilising employment. Hiring plans will remain modest as long as the outlook is uncertain, and so Chinese consumption demand seems unlikely to sustain the reopening bounce.

An important element of reviving employment is supporting China’s SME sector, which accounts for around 80% of non-government employment. Such firms have struggled the most with the cost burdens of zero-Covid, often forced to shutdown while SOEs continue production, unable to operate the “bubbles” that would allow an isolated labour force to keep working. Small firms have diverged markedly since 2020 as a result, as shown in our chart above.

Policy support is having an effect, along with the reopening of the economy. The small manufacturer PMI rose to 48.6 in June, from 46.7, its strongest reading since May 2021. But this still suggests the sector is shrinking. By contrast, large and medium firms are both above 50, even if large firms saw a dip in June.

Local governments will have to extend further tax breaks and other support, if they can afford to.

Overall, these surveys imply a good June for industrial production, retail sales, and even fixed asset investment, though we suspect the latter will still face strong headwinds from real estate, and to a lesser extent from manufacturing, given soft domestic demand. But we think they are not strong enough to prevent a quarter-on-quarter decline in GDP for Q2.

Activity will probably strengthen again in July, given the drawdown in inventories, but work backlogs are falling, and the reopening momentum is likely to fade soon, leaving growth reliant on new stimulus efforts.

The trade shock is looming but so is MOAR. Goldman:

The PBOC held its Q2 2022 monetary policy committee meeting, and the statement following the meeting reiterated a more supportive monetary policy stance. The Q2 statement deleted “maintaining stable macro leverage ratio” which was in the Q1 statement, which suggests policymakers might aim to accelerate credit growth in the near term. PBOC also pledged to “stabilize employment and inflation, to ensure supply chain stability, push for implementing a basket of growth supportive measures to achieve growth stability”. Separately, onshore media reported potential front-loading of the 2023 local government special bond issuance quota to this year, though we await official policy announcements for confirmation and more details.

China is going OK but the looming global recession will knock it sideways all over again via the trade channel.

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